Weak yen is Japan's route to recovery

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The Independent Online
For dedicated pessimists about the Japanese economy, this week's mild earth tremor in Kobe, eight months after the original devastating quake, came as a handy metaphor for the risk that structural upheavals could still threaten economic recovery. But equally symbolic was the fact that the yen's fall below 100 to the dollar became well-established this week. Indeed, the rate looked to be heading swiftly towards 105 yesterday.

The currency reached the psychological barrier last week, but it took a few days for traders to accept that they were not going to be the first mug to buy a lot of dollars at 100, and that the Bank of Japan was determined to keep the yen below that level. Yesterday, with more aggressive intervention by the central bank, the ice broke.

With this welcome relief on the exchange rate, Japanese exporters can increase output. It should help business confidence, which last week's Tankan survey reported had fallen for the first time in nearly two years.

Yet the Bank of Japan's decision to push the exchange rate down is linked to the structural problems facing the economy. A detailed analysis in the bank's annual review makes it clear how determined the authorities are to respond to the challenges from new patterns of trade and a rapidly changing industrial structure. Beating the exchange rate down is a tactic to make adjustment easier; the strategy is to deregulate the economy so that it can react faster to the new environment.

The analysis identifies three factors forcing fundamental change on the economy. One is the industrialisation of emerging economies in east Asia. The rise of the yen is another. Finally, there is the debt legacy of the late 1980s bubble, which has made lenders and borrowers cautious and slowed recovery.

The amazing growth of emerging economies has hugely increased competition for producers in all the developed countries. The phenomenon - deindustrialisation or ``hollowing out'' - hit Britain and the US earlier. The east Asian countries have accounted for about 60 per cent of the growth in world exports (and 80 per cent of the growth in imports) since 1990.

The once seemingly inexorable rise of the yen added to pressures on Japanese producers. Many Japanese economists blame the huge US government budget deficit for this.

The result of these forces has been a dramatic shift in trading patterns. Japan's exports of consumer goods have declined, but exports of capital and investment goods have risen. Trade with its Asian neighbours has grown rapidly.

So has its direct investment in the region, where labour costs are between 5 and 30 per cent of those at home. This in turn has increased the competing supply of manufactured goods, and transferred the technology to the emerging economies.

Cheap imports have led to a sharp fall in the price of final manufactures, especially consumer goods. On top of this, Japanese consumers are finally waking up to the fact that they pay much higher prices at home than abroad. The rising number of Japanese travelling overseas has probably been important in this awakening. It has, among other things, contributed to a sharp fall in distributors' profit margins in the past 12-18 months, as the chart shows.

As the Bank of Japan points out, the transition from one industrial structure dominated by consumer goods to another biased towards capital and higher technology goods is painful but should lead to a more efficient economy. The question is how to make the transition as fast and painless as possible.

The review considers two examples. Britain faced a similar challenge from the industrial growth of America and Germany in the 1870s. Britain's response, to promote agricultural free trade, shrank the agricultural sector dramatically but created the most productive farmers in the world. But it protected important manufacturing industries by putting barriers around colonial markets. Industrial restructuring was therefore very slow. The depression lasted from 1873 until 1896.

By contrast, America's response to competitive challenges in the 1980s was deregulation of several important industries, including transport, telecoms and cable TV. Despite the initial friction, there were net gains in output and jobs.

The Bank of Japan concludes that it is neither possible nor desirable to resist the structural pressures. Workers and capital must be encouraged to switch from declining to growing industries. Yet Japan rates poorly on new business formation and labour mobility. ``To ensure freer entry to and exit from industries as well as to enhance a dynamic change in Japan's industrial structure, deregulation has a crucial role,'' the review says. It cites US telecoms deregulation as a valuable model.

This suggests understandable foreign doubts about Japan's commitment to deregulation and opening its markets are likely to be overplayed - although the process of consensus-building is incomplete. For the metaphor hungry, last week's earthquake only briefly halted the bullet trains in Kobe.

The other implication is that it is in the interests of both Japan and the US to stop restructuring from being derailed by a lurch into recession and financial crisis. Even though a weaker yen will ease competitive pressures on Japan's exporters, it will enable the structural shift in the economy to continue without so much pain that special interest groups can call a halt to the process. Keeping the yen below 100 to the dollar is in everybody's interest.